Tax hikes likely as South Africa tries to plug deficit

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Finance Minister Pravin Gordhan is set to announce higher tax rates, as well as other measures, in his upcoming 2017/18 budget that could either boost the economy or deliver the final knockout punch to his career as finance minister.

Gordhan needs to find tax and spending measures that will
plug the deficit in South Africa’s budget during a
time of political instability, an ailing economy and the risk
of having its financial rating downgraded to junk status. In
his
mid-term budget policy statement (MTBPS), announced in
October 2016, Gordhan confirmed that significant tax increases
will be necessary over the next two years to raise ZAR 43
billion ($3.1 billion) in tax revenues to help stabilise the
economy (ZAR 28 billion in 2017-18 and ZAR 15 billion in
2018-19).

However, the tax options available to the finance minister
ahead of the budget statement on February 22 appear to be
limited.

Nevertheless, Dale Cridlan, tax practitioner and director of
Norton Rose Fulbright in Johannesburg, said "CEOs do recognise
that we are in a difficult economic environment at the moment
and I think there is almost an understanding that rates are
going to be increased".

However, although Erika de Villiers, head of tax policy at
the South African Institute of Tax Professionals, acknowledged
that tax increases are expected in the budget, she warned that
it is not sustainable for South Africa to balance its books by
way of tax increases. "Such tax increases are likely to limit
growth and increase inflation," de Villiers told
International Tax Review. "Government spending should
be well targeted and tightly controlled to assist in bridging
the gap between income and expenditure."

So how could the finance minister fill the budget black
hole?

Nazrien Kader, head of taxation services at Deloitte Africa,
suggested that the government could maximise its potential
by:

Introducing a surcharge tax on wealthy individuals and
all companies;

Increasing tax collection on inter-generational wealth
transfers;

Increasing the VAT rate from 14% to 15%;

Introducing a sugar tax;

Balancing its fiscal drag;Introducing fuel levies among
other 'sin’ taxes;

Improving tax collection and compliance; and

Boosting tax revenues through the voluntary disclosure
programme.

By incorporating these measures, Kader said the
government could raise more than the necessary ZAR 43
billion.

For businesses, the 'wish list’ is a little
different. Tracy Brophy, head if tax risk management at
FirstRand Group Tax, said "corporate South Africa is looking
for a reduction in expenditure (wasteful, corrupt or otherwise)
by government, since the deficit cannot simply be solved by
raising tax revenues. So, any well thought out and achievable
proposals in this regard would be welcome".

"With regard to tax changes, there is a substantial amount
of specific anti-avoidance legislation, aimed at specific
transactions or structures, being promulgated in South Africa
annually, which needs to be debated with National Treasury to
ensure that the mischief they seek to curtail is caught rather
than commercial transactions. In this regard, it would be nice
to see a reduction in the amount of specific anti-avoidance
legislation for this cycle in favour of the South African
Revenue Service relying on the general anti-avoidance
provisions to target any impermissible tax avoidance," Brophy
said, adding that she also expects more BEPS-related
initiatives to be announced.

However, nothing is quite so simple.

Corporate tax rates to remain steady

South Africa’s corporate tax rate stands at 28%
and there is a possibility of increasing this by a few
percentage points to raise tax revenues, but this is
doubtful.

Cridlan said that a higher corporate tax rate is unlikely
because it would not generate the necessary revenue and would
instead "chase away" foreign investment.

If Gordhan chose to raise the tax rate, however, it would
not go above the 32% rate in neighbouring Namibia, or
Africa’s highest corporate tax rate of 35% in
Zambia.

Nevertheless, any increase would mean South Africa would be
going against the global downward trend and be above the
average 2016 rate across Africa of 27.46% and the global
average of 23.62%, according to KPMG’s tax table
for 2016.

In addition, Cridlan believes corporate tax incentives are
unlikely to change much, with only some "tweaks" being
proposed.

However, Deloitte’s Kader said that although a
corporate tax hike may not happen, businesses should be ready
for "far more vigorous enforcement", driven by a focus on BEPS
and the widening tax gap (the difference between what we ought
to be collecting and what we are actually collecting).

Little space to raise corporate capital gains taxes

Another option to generate more tax revenues could be
increasing capital gains taxes (CGT) for corporations, but only
a slight rise is possible.

Last year, the government increased the amount of gains that
would be subject to CGT from 66.6% to 80%, leaving the
government with little room to raise it further this year,
according to Cridlan.

"If you look at a corporate, for example, what would happen
is that 80% of any gain is included in a
corporate’s taxable income and taxed at 28%. So,
what they did is increase the 80% from 66.6% last year. If they
were to increase the 80% to 90%, then there is not much of a
difference from 90% to 100%. So, you are then effectively
taking away – our CGT rates are lower than income tax
rates and effectively by increasing that CGT rate you are not
distinguishing between an income tax rate and a CGT rate. So,
there is not too much room left to manoeuvre – not on
the CGT side."

However, individuals could face an increase in the CGT
because the proportion of capital gains subject to tax is 40%
for individuals.

VAT hike ideal, but not possible

With such a large tax gap to fill, many tax practitioners
believe a rise in the VAT rate would be the best way to help
resolve the deficit and prevent a ratings downgrade.

Kader said that raising the 14% VAT rate to 15% could
generate ZAR 15 billion of additional revenue, but would also
reduce GDP by between 0.2% and 0.4%, and would also increase
inflation.

Although South Africa’s VAT rate is
comparatively low by international and even African standards,
Cridlan said the government sees it as a regressive tax. "In
other words, it’s going to do more harm to poor
people than it is to the rich people. And it is seen as a tax
that will hit everybody across the board," Cridlan said. "On
the one hand, that is maybe something that South Africa needs
to collect taxes more broadly, but every year we predict an
increase in the VAT rate and it never happens. I think VAT is
just too much of a political hot potato for them to increase
the rates, so I don’t think we are going to see an
increase in the VAT rates."

An increase in the rate could cost the ruling ANC party to
lose voters and become unpopular. The political issues, coupled
with the economic impact of a VAT rate rise mean this is very
unlikely.

"Whilst an increase in the VAT rate would impact the entire
economy, which the trade unions are fighting on the basis of
hardship to the poorer tiers in our society, the Davis Tax
Committee has released statistics which indicate that personal
income tax and corporate income tax would need to be increased
by 6% and 5%, respectively, in order to generate the same
increase in revenue as a 3% increase in VAT (and a VAT rate
increase would have a less negative impact on GDP and
employment, since an increase in personal income tax may
encourage a flight of skills and an increase in corporate
income tax would be a serious disincentive to foreign direct
investment)," said Brophy. "It has also been estimated by
certain economists that a 2% increase in the VAT rate may
extinguish the deficit. So, the statistics speak for themselves
in terms of which 'tax lever’ would generate the
most additional revenue in the most effective way."

Nevertheless, Cridlan said "it just looks like VAT is not
going to be touched".

Carbon and sugar taxes

South Africa has been planning to introduce a carbon tax and
sugar tax for some time. However, the proposals have been
stalled at various stages and seem unlikely to be introduced in
2017 as planned.

Cridlan said that big announcements are not likely on the
planned carbon or sugar tax in the budget. Instead, there could
be some clarity about the direction that government plans to
take, with carbon tax being postponed for a further year as
stabilising the economy is the bigger concern.

However, Kader said that if the government did introduce the
sugar tax, it could potentially generate around ZAR 11 billion
in tax revenues, based on preliminary research.

On other 'sin’ taxes and fuel levies, if the
government raised these above inflation, then they could
achieve about ZAR 9 billion in additional tax revenues, Kader
added.

On carbon tax, Kader said that more details are crucial to
held taxpayers to prepare for its introduction. "The carbon tax
could make a significant dent in South Africa’s
budget deficit, making it more likely that the tax will be
introduced sooner rather than later," Kader said. "A draft of
the bill has already been released with a planned
implementation date of January 1 2017. Many comments were made
on this bill and a new draft is expected early in 2017 with a
view to implement the legislation in 2018. There are several
outstanding issues that need to be addressed in the revised
legislation. Possibly one of the more pressing of these issues
is the emissions threshold for paying carbon tax. It is also
unclear who the taxpayer will be. There are some indications
that groups of companies would be liable, but tax is normally
levied at company level."

"Although a carbon tax is relatively simple in structure,
its implementation is likely to be difficult," Kader added.
"This is because carbon taxes are based on fossil fuel
consumption, which is not currently measured in the same amount
of detail as expenditure and revenue, and is usually not as
readily available as financial line items."

Compliance and TP measures possible

An alternative to numerous tax rate increases is better tax
collection through efficiencies in the tax authority.

"The Common Reporting Standard might generate an additional
source of revenue with government authorities worldwide
cooperating with each other. We could see some tax efficiencies
on the tax collection or compliance side, making our revenue
authority more efficient in collecting taxes," said
Cridlan.

In addition, Kader said that South Africa’s
special voluntary disclosure programme, which aims to bring
undisclosed foreign investments held by South Africans into the
tax net, could generate significant tax revenue –
potentially at least ZAR 10 billion. "Although the amount will
only be known when the programme ends in June 2017. The last
amnesty in 2003 yielded ZAR 48 billion," Kader said.

On transfer pricing, Kader believes that further changes
could be announced in this year’s budget after the
introduction of country-by-country reporting and detailed
record retention rules in 2016. "This is likely to keep
taxpayers busy, but there may well be further changes
announced," Kader said.

Personal income taxes to rise

With little room to move on businesses taxes, the evidence
points to higher taxes for individuals.

Both Cridland and Kader said this was the most likely
option, with the rate potentially increasing from 41% to as
high as 45% for the top bracket of taxpayers.

"The marginal tax rate for high-earning individuals could be
increased from 41% currently to 45%, which would yield an
additional ZAR 3.5 billion in revenue," Kader said. "In
addition, the National Treasury could apply a special levy or
surcharge to individuals earning above a set threshold. This is
also likely to apply to companies based on turnover as a means
to collect some tax from companies when profits are
non-existent."

Spending cuts could mark the end of Gordhan’s
career as finance minister

In addition to potential tax hikes, spending could be
restricted to show that government ministers are not exploiting
taxpayer funds for their personal gains.

"There’s almost an announcement every day of
some further government wastage on cars or whatever the case
may be. So, we could see some further tightening of belts as
far as expenditure is concerned," Cridlan said.

These spending restrictions could see Prime Minister Jacob
Zuma deal a big blow to Gordhan’s career but if
the South African finance minister was replaced, investor
confidence is likely to fall dramatically.

"I think there is a sense that the current government would
like for various reasons for the finance minister to go. To be
replaced. But I’m hoping that it
doesn’t happen because it is not going to be
perceived very well by the investment community," said Cridlan.
"As we have seen historically, it isn’t a move
that is favoured very well among investors, but there are some
noises. There is has been some rumblings that there could be a
shuffle in the cabinet."

The weeks leading up to the annual budget on February 22
could be turbulent for the government, but what is announced on
the day and how it is perceived by taxpayers, financial ratings
agencies and foreign investors could have a big impact on how
the South African economy succeeds – or fails
– in the coming year.